Can You Use a 529 Plan To Pay Student Loans? Here’s What You Need To Know

Around 30% of families paying for college in 2023 used a college savings fund, like a 529 plan, according to a study from Sallie Mae and Ipsos. Data from the College Savings Plans Network shows that as of June 2023, the average 529 plan balance is $27,741.

With many families using a 529 to pay for school, making the most of the funds is often a top priority. For some families, paying off student loans with a 529 plan is an efficient option. Here's a closer look at how to use a 529 to pay for student loans, including the restrictions, pros, and cons.

Can you use a 529 to pay student loans?

The SECURE (Setting Every Community Up for Retirement Enhancement) Act of 2019 changed the 529 plan distribution rules. Now, in addition to using a 529 plan for qualified education expenses like tuition, savers can use the funds from a 529 to pay down student loan debt.

Plan beneficiaries can withdraw up to $10,000 total from a 529 to pay down principal or interest on their student loans. Beneficiaries can also use their 529 funds to pay down a sibling's student loans.

How much of your 529 can be used for student loans?

If you want to use your 529 funds to pay off student loans, you can withdraw up to $10,000 to pay down student loan principal or interest. This is the maximum lifetime amount you can withdraw from a 529 for the purpose of repaying your student loans; it's not an annual limit.

For plan beneficiaries with siblings who have student loans, you can withdraw an additional $10,000 per sibling to pay down their student loans.

Benefits of using a 529 to pay student loans

Using 529 funds to repay student loans comes with many advantages, including:

• Reduce student loan interest payments: Even if $10,000 isn't enough to eliminate your student loans, it may be enough to reduce your principal balance significantly. With a lower loan balance, you'll pay less interest as you pay down the rest of your loans.
• Tax advantages: When you withdraw up to $10,000 from your 529 to pay down student loans, you'll avoid paying any income tax or tax penalties on the distribution. For savers with extra funds in their 529 after graduating, paying off student loans offers a tax-efficient way to use the money.
• Help out a sibling: The tax benefits still apply when taking out up to $10,000 per sibling to pay down student loan debt. Plus, helping out a sibling offers more than simple tax efficiency.
• Help another family member: It's possible to change the plan beneficiary to someone else in your family, like a cousin, to help them pay down their student loans. Keep in mind that this person must be an eligible family member per IRS rules.

Drawbacks of using a 529 plan to pay student loans

Like all financial decisions, there are some drawbacks to using a 529 plan to pay down your student loans. These include:

• Limited repayment amount: You can only withdraw up to $10,000 without incurring tax penalties. Depending on your situation, this could wipe out your loans or barely make a dent.
• Loss of a tax deduction: You cannot claim the student loan interest tax deduction on the portion of your student loan debt you used 529 funds for. The student loan interest tax deduction can reduce your taxable income by up to $2,500.
• Opportunity costs: Withdrawing funds from your 529 now prevents you from growing those funds for future educational expenses. For those planning to continue their education, this could limit your 529 savings.

What to consider before using a 529 for student loans

While there are many benefits of using 529 funds to pay down your student loans, it's important to weigh all the details of your situation before moving forward.

If you want to take out more than $10,000 from your 529 to pay off your debt, you'll pay a 10% penalty and income taxes on the amount above $10,000. When you add up all the taxes and penalties of a large withdrawal, it might not make sense to use more than $10,000 to pay down your loans.

For borrowers with many student loans to juggle, it might make sense to use the $10,000 to wipe out your debt with the highest interest rate first. For students who plan to return to school, using the funds in your 529 to pay for loans now might jeopardize your ability to pay for education costs in the future.

You may be able to roll up to $35,000 from your 529 plan into a Roth IRA if you meet certain requirements, which can kick-start your retirement savings journey. Taking a hit to your funds due to a tax penalty to eliminate your loans might not be the right move for your future.

Alternative repayment strategies

Whether you don't have enough saved in a 529 to cover your loans or you want to use the remaining funds for another purpose, there are other student loan repayment strategies to consider. These include:

• Alternative repayment plan: Federal student loan borrowers might be able to tap into income-driven repayment plans. These plans can lower your monthly payment and set parameters for when your debt is eliminated. Weigh the cost of using your 529 vs. lowering student loan payments.
• Employer repayment programs: Some employers offer to match your student loan payments. Typically, this comes with annual and lifetime limits. But even with the limits, this could supercharge your repayment journey. 
• Student loan refinancing: If you can refinance your student loans into a loan with a lower interest rate, that could help you get out of debt faster. But think carefully before refinancing federal loans into a private loan, as this will cause you to lose access to benefits like loan forgiveness and income-driven repayment plans.
• Debt snowball or avalanche method: For borrowers with monthly funds available for debt repayment, consider using that money to eliminate your smallest debt (with the debt snowball method) or debt with the highest interest rate first (with the debt avalanche method). When you wipe out one debt, you can roll that monthly payment into paying off your next loan.
• Seek loan forgiveness: You might qualify for student loan forgiveness if you have federal student loans and work in a qualifying field for an eligible employer. 

FAQ

How much of my 529 can I use to pay off student loans?

You can use up to $10,000 from your 529 to pay down your student loans.

Can I use a 529 to pay off my sibling's student loans?

Yes, you can use the funds from your 529 to pay down your sibling's student loans. The maximum amount you can withdraw per sibling for student loan repayment is $10,000.

Will using a 529 for student loans affect my taxes?

If you withdraw $10,000 from your 529 to pay off your student loans, that won't impact your taxes. But when you withdraw amounts above the lifetime limit of $10,000, expect to pay taxes and a 10% penalty on the withdrawn amount. You also can't claim the student loan interest deduction for student loan interest that you repaid with 529 plan funds.

What are the limits of using a 529 for loan repayment?

You can use up to $10,000 of your 529 funds to repay your student loans. Additionally, you can withdraw up to $10,000 per sibling to use for their student loan repayment.

Are there penalties for using a 529 for non-education expenses?

When withdrawing 529 funds to pay for a non-education expense, expect to pay a 10% federal tax penalty. Additionally, the earnings withdrawn will be subject to federal and state income taxes.